February 12, 2010

Bill Gurley Discovers Virtual World Bean Counting

Why there is a difference between the provider and the consumer

by Jessica Holyoke

Over on above the crowd blog, Linden Lab board member Bill Gurley talks about a sit-down meeting with Jeff Grabow of Ernst and Young. Presumably this was in a real office and not in an immersive workspace premium collaboration solution. In this meeting, Mr. Grabow discussed some accounting principals that should be followed when looking at virtual world providers.

One thing he pointed to was that virtual currency would not be revenue when sold by the company but a liability, something more like a cash deposit by a customer. Its not revenue yet. It becomes revenue when it is used to buy a virtual world good or service. This makes perfect sense with a platform like World of Warcraft or even Island Life, where the goods and services are provided by the platform provider. When a player buys an outhouse or beach toys with coins they purchased from the provider, then the money used to purchase the coins becomes revenue.

The problem for Linden Lab is that this accounting method does not apply to Second Life.

Only Supply Linden, the source of excess Linden dollars on the LindeX when demand threatens to raise the exchange rate due to lack of supply, prints any Linden dollars. Most Linden Dollar transactions are trades and not pure purchases. In Island Life, when a user buys the coins, the coins are 'minted' by the provider and eventually the coins go back to the service provider. In Second Life, when a resident trades dollars for Linden dollars, they can use them in transactions with other residents, and those residents do not need to cash them in with the Lab. Therefore, the accounting advice Gurley is receiving and discussing, does not apply to Linden Lab. Revenues would include tier payments, membership fees, land auction purchases and LindeX transaction fees - in other words, everything VAT is applied to. However, VAT is not applied to Supply Linden transactions. Which makes sense in that if the Supply Linden purchase is a deposit, then VAT shouldn't apply. Even though that deposit will not become revenue unless the customer uses it to purchase something directly from Linden Lab.

Another issue with that accounting method is that time and again, classified ads and upload fees are not revenue for the lab, but rather sinks to keep the price of Linden dollars down. With what Grabow is saying, and Gurley talking about, is that this is one of the few instances were a Linden dollar transaction between the Lab and the resident should be counted as revenue and not tossed off into another column as a 'currency reclamation'.

Now the next part of what Gurley brings up is also where he mixes up how Second Life does business and how other virtual worlds do business. When I buy coins on Island Life and then turn around and buy a virtual good or service from the provider, then the provider can amortize the revenue for as long as the good is used. So if I spent $1 on a tree, then so long as I use the tree, by signing on and using the platform, then that $1 is revenue over the period of use. The thing about Second Life is that Linden Lab might try to extend revenue over land sales, over the life of how many times it is sold, but included in that purchase of the right to server space is a monthly tier payment. So the Lab gets an amortized payment over the lifetime of the server as well as a monthly payment for that portion of the server. Which also could mean that abandoned Governor Linden land on the Mainland could function as a loss, its still running and no one is paying tier on it, or it allows the lab to amortize the initial land payment longer, meaning if I paid $500 for the land and I later abandon it, the Lab could make an argument that the average amortization would still apply to it, if other residents keep their land longer.

Lastly, the article went into how rentals might be a good system for virtual world providers. One reason is that an inventory wouldn't be over bloated with items if they consistently had to be replaced. Another is that a rental period allows for a set time for amortization, instead of trying to figure it out over many different users and uses. Which again is problematic because outside of land rentals, the Lab does not produce a good or service. Additionally, our inventories contain things like scripts and textures that are used to produce other things. Going with a consumable good economy would destroy how Second Life works, but would be acceptable in other provider-dominated platforms.

What was quoted is great advice for most platforms out there without user generated content, but as far as Linden Lab and Second Life goes, they cannot follow this advice.

5 Comments

Something I forgot to put into the main article. While Supply Linden prints Linden dollars for the Lindex, the Lab has also printed Linden dollars up in the past as part of stipend payments. Sometimes this is associated with a premium membership so that part of the premium paid would be the liability. But sometimes, with a basic account, Linden dollars were given without asking for a payment to be made. Which means if the Lab tracked outstanding Linden dollars as liabilities, and when redeemed as classifieds or uploads as revenue, then they would have more liability out there than revenue received because they printed up Linden dollars that are not backed with currency. The same thing happens with other virtual worlds, such as Island Life where you can earn coins. On other worlds, such as Adventure Quest, in world currency cannot be bought and only special currency can be bought. Meaning the scheme of using virtual currency as a liability until exercised is easier to account for on Adventure Quest, than it is on Island Life or Second Life.

While content doesn't apply to the rental model he was talking about, land sales do conform. So theoretically, they can amortize the income from land sales over many months and not just count it in the year of sale. Which also raises the question of what happens if they reclaim the land for lack of payment of tier?